The Commodity Channel Index (CCI) evaluates the present price level about an average price level over a specific period. When prices significantly exceed their average, the CCI registers a high value. Conversely, when prices are well below their average, the CCI indicates a low value. This approach enables the CCI to detect conditions of overbought and oversold markets.
What is Commodity Channel Index?
The Commodity Channel Index (CCI) is a momentum-based oscillator utilized to determine when an investment vehicle is nearing an overbought or oversold condition.
Developed by Donald Lambert, this technical indicator analyses the direction and strength of price trends, enabling traders to decide whether to enter or exit a trade, avoid taking a trade, or add to an existing position. In this manner, the indicator can generate trade signals based on its specific actions.
Working Of CCI indicator
The Commodity Channel Index (CCI) measures the deviation of an asset’s price from its statistical mean. Operating within a range, typically from -100 to +100, values exceeding +100 indicate an overbought asset, while values below -100 suggest oversold conditions. The CCI calculation involves three primary components: the typical price, the mean deviation, and the moving average.
Formula-
The CCI is calculated using the following formula:
CCI = (Typical Price−SMA) / (0.015×Mean deviation)
Where:
– Typical Price = (High + Low + Close) / 3
– SMA = Simple Moving Average of Typical Prices
– Mean Deviation = Mean Deviation of Typical Prices
How To Calculate Commodity Channel Index?
Determine how many periods your CCI will analyse. Twenty is commonly used. Fewer periods result in a more volatile indicator, while more periods will make it smoother. For this calculation, we will assume 20 periods. Adjust the calculation if using a different number.
1. In a spreadsheet, track the high, low, and close for 20 periods and compute the typical price.
2. After 20 periods, compute the moving average (MA) of the typical price by summing the last 20 typical prices and dividing by 20.
3. Calculate the mean deviation by subtracting the MA from the typical price for the last 20 periods. Sum the absolute values (ignore minus signs) of these figures and then divide by 20.
4. Insert the most recent typical price, the MA, and the mean deviation into the formula to compute the current CCI reading.
5. Repeat the process as each new period ends.
Source: E. Ponsi. “Technical Analysis and Chart Interpretations: A Comprehensive Guide to Understanding Established Trading Tactics,” Pages 283-287. John Wiley & Sons, 2016.
Advantages Of The Commodity Channel Index
The Commodity Channel Index (CCI) is a technical indicator with several advantages:
– It can be used to identify oversold and overbought conditions.
– It can help in spotting trend reversals.
– It can highlight trading opportunities.
– It is relatively easy to use and understand.
– It can be combined with other technical indicators to enhance its accuracy.
Specific Benefits of Using the CCI:
1. Identifying Overbought and Oversold Conditions
The CCI can pinpoint when security is overbought or oversold, providing signals to sell or buy. When the CCI is above +100, the security is deemed overbought and may be due for a correction. Conversely, when the CCI is below -100, the security is considered oversold and may be poised for a rebound.
2. Identifying Trend Reversals
The CCI can also detect trend reversals. A cross above +100 can signal the start of a bullish trend, while a cross below -100 can indicate the onset of a bearish trend.
3. Ease of Use and Understanding
The CCI is straightforward to use and understand, making it accessible even for beginner traders. It is also relatively inexpensive to implement.
4. Compatibility with Other Technical Indicators
The CCI can be used in conjunction with other technical indicators to improve its accuracy. For example, combining the CCI with moving averages can help identify trend changes more reliably.
Using commodity channel indicator
Here are some specific guidelines for using the Commodity Channel Index (CCI):
1. Typical Price: The typical price is calculated by averaging the High, Low, and Close prices over a specified period. The most common period used is 20 days.
2. Moving Average of Typical Price: The moving average of the typical price is determined by taking the simple moving average (SMA) of the typical price over the specified period, typically 20 days.
3. Mean Absolute Deviation of Typical Price:* The mean absolute deviation is calculated by averaging the absolute deviations of the typical price from the moving average over the same period, commonly 20 days.
4. Overbought Condition: The CCI is considered overbought when it exceeds +100.
5. Oversold Condition: The CCI is considered oversold when it drops below -100.
6. Buy Signal: A buy signal is generated when the CCI crosses above -100.
7. Sell Signal: A sell signal is generated when the CCI rises above +100.
Overbought And Oversold Levels In CCI Trading
Overbought and oversold levels indicate extremes in market sentiment. When the CCI surpasses +100, it suggests that the price has risen significantly and may be due for a correction. Conversely, when the CCI falls below -100, it indicates that the price has declined considerably and might rebound soon.
CCI Divergence
CCI divergence occurs when the direction of the CCI diverges from the price trend. Bullish divergence happens when the CCI forms higher lows while the price forms lower lows, potentially signalling an uptrend. On the other hand, bearish divergence occurs when the CCI forms lower highs while the price forms higher highs, indicating a possible downtrend.
CCI Trend Line Breaks
Trend line breaks using the CCI involve drawing trend lines on the indicator itself. A break above the upper trend line suggests a potential continuation of an uptrend, while a break below the lower trend line indicates a possible continuation of a downtrend.
Conclusion
The Commodity Channel Index (CCI) is a versatile tool that empowers traders to make informed decisions regarding market trends, entry and exit points, and potential reversals. By understanding the workings of the CCI, learning how to calculate it, and interpreting its signals, traders can enhance their trading strategies and achieve greater success in the dynamic world of finance. Understand the basics of the forex market to be a profitable trader.